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222: The Dollar Milkshake Theory with Brent Johnson

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Buck: Welcome back to the show everyone today my guest on Wealth Formula Podcast is Brent Johnson. Brent is the CEO and portfolio manager at Santiago Capital in San Francisco which he formed after a successful lengthy career with private clients at Credit Suisse. Brent’s Dollar Milkshake Theory has been circulating on the internet and on the podcast circuit and he’s here today to explain it and discuss it. Brent, welcome to Wealth Formula Podcast.

Brent: Thanks for having me. Happy to be here and looking forward to speaking with you.

Buck: Well great, thanks. You know before we jump into the theory itself, you know we have my listeners, people like me right maybe we’re kind of smart because we went to med school or we went to law school or whatever, but we may not be quite that sophisticated on you know the nuances of the financial markets that are going on right now. So do me a favor give us a little bit of background on the economic situation the situation with the markets that we’re in as a country at sort of the macro 101 level that sort of leads into your theory.

Brent: Sure. Well so, first of all, I would say that you know I think everything I do, I start with a very big picture and then I drill down in more detail and more detail and more detail. So I’m very much a big picture person and as you know over the last couple years well actually over the last decade you know since the global financial crisis I’ve really dug deep into the macro world and not only the macro world which you know for those who don’t know it’s basically the big picture the country by country basis and interest rates you’re not necessarily looking at the balance sheet of an individual company, but looking at big overall trends and global you know things that are happening on a global basis and as part of that I really dug into central banking and the way the monetary system is designed to just kind of understand how money gets into the system how it flows why it flows what are the different things that influence it and you know in doing that I started I got into that probably about 2006 or 2007. I had kind of this fortuitous meeting you know when I was still at Credit Suisse and I realized that all the people I thought were experts really weren’t as smart as I thought that they were and since they couldn’t give me the answers and they would laugh at me if I asked these what I thought were good questions but they thought were silly so I basically had to go find the answers myself and through that whole process of self-discovery and self-education I got a better understanding of how the monetary system actually works and I discovered that the situation for the United States was not very good for lack of a better word. So I didn’t predict the global financial crisis but I was ready for it when it happened now subsequent to that the global financial crisis over the last 10 years the central banks and the monetary authority authorities around the world have for lack of a better word flooded the market with liquidity because it wasn’t just the United States that was in trouble in the global financial crisis it was kind of the whole world. And so over the last 10 to 12 years we’ve seen the whole world you know reflate as they pump the liquidity into the markets but with sporadic crises popping up you know every couple years in different parts of the globe. And it was through that work that I I initially thought that the dollar was in big trouble because of the bad situation that the United States was in and in hindsight I think I did really good analysis on the United States and a lot of other people have done really good analysis on the Snited States. But what I discovered in probably 2016 was that while I had done fantastic in my own opinion analysis on the United States I had not done the same level of analysis on the rest of the world. And so I was kind of analyzing the United States in a vacuum but the reality is we don’t live in a vacuum. It’s a global world it’s a global market you know money doesn’t just stay in the United States. It flows all over the world and money that gets created in Germany doesn’t just necessarily stay in Europe it can flow the United States or South America. And so when and then the last thing you got to realize is that currencies fiat currencies. Fiat currencies are basically countries or you know the paper currencies that countries issue these are not backed by anything they’re not backed by gold they’re not backed by oil they’re not backed by land so it’s really the promise that the government the tax revenue of the citizens that’s what backs the currencies and so what I realized while I had done good analysis on the US Dollar I had not held the same level of critique to the other currencies and the reality is that all these fiat currencies trade relative to each other. They don’t trade on an absolute basis they may trade on an absolute basis versus something like gold but against each other they trade on a relative basis. So if you have 10 people lined up and you’re trying to pick out the smartest one and but they’re all idiots one of them is still going to be the smartest idiot yeah right yeah and so and so the smartest idiot is going to do better relative to the other nine and when I started thinking about it and when I started really kind of analyzing the way the system was designed and the way that it functions and the way it’s enforced is that despite all the problems for the United States, that it had numerous advantages over the other currencies and a lot of those other currencies had the same problems as the United States.

Buck: So we’re the least ugly country in the room.

Brent: Yeah and it’s kind of a silly analogy but it’s correct and it’s kind of this some people say well that’s too simplistic and well yeah it is simplistic but that doesn’t necessarily mean it’s wrong. And so it was through that work that led me to my Dollar Milkshake Theory and in essence the Dollar Milkshake Theory.

Buck: Before you start with that let me ask you this and it’s a very simplistic question but I think it’s one that people, so okay so we’re talking about whether the dollar ultimately is strong or is it going to be weak. Why does that matter?

Brent: Well it matters for a couple of reasons. If it’s weak on an overall, on an absolute basis then your purchasing power over time is going to fall and that has huge implications for your savings account or your retirement account or the way you want to live in the future. You may think you have plenty of savings to live the rest of your life and in the style through which you’ve become accustomed, but if the cost of living goes up significantly in the future you may not be able to live as well as you think you will. Now if prices fall then that would be good for your you know your savings account would increase in value, but if the value of the dollar loses time over time value over time then your savings may not be enough to sustain you through that time period so that’s why it’s important on an absolute basis. And then it’s also important on a relative basis because you know that relative prices of currencies are what drive capital markets and capital markets involve things like interest rates and stock markets and real estate markets and so you know the flow of capital into a country or into a region typically accompanies a strength of that currency and it typically indicates you know a positive flow of asset prices. Like if all of the capital was leaving the country then that would be bad for those assets in that country or that country so it’s important for both of those reasons.

Buck: Got it and that’s really important I think just to set the stage again because really this whole thing is about ultimately the strength of the dollar and you know how that affects everything else. So you know guys like Peter Schiff out there are saying that the dollar is about to crash because the amount of money we’re printing and that gold is going to go through the roof. So why is he wrong and this is probably you know ties in with explaining your Dollar Milkshake Theory.

Brent: So the first thing I’d say is he’s not completely wrong. He’s right on part of it but he doesn’t have the whole picture I don’t think. And then the second thing is that I have said many times that I think Peter is probably as good as anybody is explaining where we’re going to end up and why we’re going to end up there. I just don’t think he has a good understanding of the road that we’re traveling to get to that ultimate destination that he has laid out, and the again the part of the reason I say that is because again fiat, so he may be correct in that the dollar is going to lose value versus gold and gold is going to go through the roof, I happen to agree with him that over the next you know three to five to ten years, gold’s gonna go to five thousand dollars and potentially much higher than that. So on that perspective we’re completely in agreement but when he says the dollar is going to zero, maybe versus you know again physical assets or gold but versus other currencies I think he’s completely wrong, in other words versus the Euro or versus the Yen or versus the Yuan I think he has it completely wrong because I don’t think he understands the supply-demand dynamics of the dollar versus the supply and demand dynamics of those other currencies. And the advantages that the United States has and the disadvantages that those other countries have again I think he has a very good understanding of the destination but not the path which we follow to get there.

Buck: So tell us about the Dollar Milkshake Theory.

Brent: Yeah so the Dollar Milkshake Theory, I came up with it after watching a movie you know four or five years ago this movie called There Will Be Blood. It was about this ruthless oil executive who just hated his competitors and would do anything to beat them and he was trying to buy some land that had oil on it and the you know his competitor wouldn’t sell him the land so he basically said well you know what I own the land right next door so I don’t really need to buy it from you I’m just going to stick a straw down I’m going to stick a pipe down into the ground on my side of the fence and I’m going to suck up your oil and he said I’m going to drink your milkshake. So I don’t really need to own the land I just need to be able to have a straw to stick down in there and that and I thought about it and that’s really kind of what I think is going to happen over the next two to three years in the United States. So over the last 10 to 12 years as I said earlier all the central banks got together and after the global financial crisis, they injected liquidity into the market. Now you know they call it QE, they call it you know fiscal stimulus there’s a number of different names that they use for it but essentially they’re pumping new liquidity into the system. And my point is is that it’s not so much important who injects it, what’s really important is who captures it or who sucks it up. And from let’s call it 2009 to 2015 all the central banks were doing it in unison but in 2016 the US started raising interest rates and so we started rather than pushing, injecting liquidity in we were pulling liquidity up into the United States by raising interest rates. And so as I said we started drinking that liquidity that the rest of the world was mixing. Now that interest rate the higher interest rates are the raising of interest rates stopped in 2019 and since then we’ve actually been lowering interest rates but on a relative basis, our interest rates are still much higher than most of the rest of the world and in addition to that so while the the the raising of interest rates were part of the straw that would suck up that liquidity they weren’t the only component of it there’s a number of other components that I think give the United States an advantage that sucks that capital to the United States. The first one is that we have the biggest and the deepest capital markets in other words we can absorb all these flows because our capital markets are so big and there’s so much demand for them. The second thing is that the dollar payment system is what is so when you think about money traveling around the world or when you well if you wire money from the United States to Brazil or if Brazil wires money to Japan it typically flows through the channels of the dollar payment system because the dollar is the global reserve currency we’re the worthy global superpower we’ve designed the system through which banks communicate with each other. So we control that system and we can either let people access the system or we can kick them out of the system and we’ve done that there’s been several times over the last you know couple decades where we’ve kicked people out of the dollar payment system. We’ve done it to Russia we’ve done it to Iran we’ve done it to Venezuela. It’s part of putting financial sanctions on other countries. And so that’s a so you know the fact that we control the dollar payment system is a big part of the straw. The other thing is that we have relative to a lot of other countries we have you know regulations that are pro-business, you know we don’t have any capital controls. If you wire money into the United States you can send it back out it’s not the same you know in places like China or Venezuela or Russia, they don’t have the same capital controls or we don’t have the same capital controls that many other countries do. And then finally and a lot of times people don’t like me saying this, but it is, in fact, true is that you know the US military plays a big part in this the US military enforces the United States role as the global hegemon and if a country does something that we don’t like there’s always the military option. Now I don’t like saying that I don’t necessarily like this option I don’t like this policy that the United States uses but it is in fact a policy that we do use and it’s one that needs to be taken into consideration. So that’s just a few of the factors that I think lead to the US being the number one destination for global capital.

Buck: And again it really comes down to this idea that we are the you know least ugly country financially in the room and you know we also are the one with like the big gun right? So all this money comes in and that creates a demand for the dollar and that then, therefore, inflates our asset prices in the US.

Brent: That’s right. And there’s one other aspect too that I didn’t mention and that is debt. So when you borrow money, you’re basically creating demand for those dollars in the future, you know if you borrow money you’re getting money today but you have to pay it back 5 10 15 years down the road. And so you’re creating demand on a yearly basis to service that debt and then you’re creating demand for the ultimate repayment of that loan in years in the future. And what has happened since the global financial crisis is that the dollar debt in the world issued by countries or entities outside the United States, so entities corporations companies individuals countries they all issue dollar-denominated debt, even though they’re not a US entity and that amount of US Dollar debt issued by global entities has more than doubled in the last 12 years and until the entire system changes that is demand for dollars. So there’s an incredible amount of demand for dollars both inside the United States because it’s our currency, but then there’s there’s this whole second market the dollars that exist outside the United States and those are called Euro dollars and there’s a huge Euro dollar market that is huge demand for dollars outside the United States. So we have these two markets the domestic market and the offshore market for dollars and the interesting thing is that the offshore market for US Dollars is bigger than almost any other currency all on its own. So if you look at the entire market for Euros both the onshore and offshore market for Euros it’s about the same size as just the offshore market for dollars so the point is is that there’s incredible demand for dollars not just inside the United States but by the rest of the world as well.

Buck: So tell me obviously this theory predated the pandemic. Is the pandemic here and the crisis is this accelerating?

Brent: Yeah so also it’s really kind of an interesting thing and I’ll walk through it slowly to kind of layout why that is. So we have been of the opinion that we were set up all the all the conditions were there for a crisis of the of the supply-demand imbalance between the supply of dollars and the demand for dollars we knew there was an imbalance and we knew something would happen to make that imbalance kind of go out of whack even more and that the price of the dollar would rise very fast. And the pandemic is probably the last thing that we ever would have thought of to do it but essentially what happened was when global commerce stopped and when trade stopped as a result of the covid and the virus and you know people stopped flying and people stopped trading and ships stopped going and it basically also took the velocity of money or the speed with which trade was taking place to zero for lack of a better word right. And so all these people that needed these dollars to pay their loans to to to to buy this inventory to do whatever it was they couldn’t get the dollars anymore so we got in march we got into this dollar funding squeeze where the dollar appreciated you know six or seven percent which is a lot for a currency to appreciate six or seven percent over a couple weeks that’s very big especially when it’s the global reserve currency that everybody needs. And so and the antithesis of that was everybody had to sell assets in order to get the liquidity because they weren’t getting it through trade they had to sell what they had in order to get the liquidity and that’s why we saw the huge sell-off in the markets in March. And so there was this huge demand for dollars because the velocity of money had gone to zero but what has taken place since then is then the central banks came in the fed came in and not only did the central bank provide new liquidity and pump new money in but there was a number of programs that were put in place to defer dollar payments, in other words you could call your bank and say can I defer my mortgage for three months or six months or whatever and they would say yes, now they didn’t forgive those payments you still owe them but they would let you defer it for six or seven months, same thing with rents same thing with us with cross-border finance, a lot of trade around the world again takes place in dollars. If brazil trades with Japan a lot of times that trade will take place in dollars but if you ordered let’s say a million dollars worth of inventory from a supplier in China but they didn’t actually ship it to you, well then you’re not going to pay for it either. So while in the very short term it caused a big demand for dollars, the fact that payments have been deferred and at the same time that the fed was flooding liquidity in, it gave a temporary oversupply of dollars so you’ve seen the supply of dollars fall or you’ve seen the price of dollars fall back over the last three or four months but our argument is that as soon as trade starts happening again as soon as all these payments that have been deferred have to be made again that you’re going to see a re-emergence of this dollar shortage where there’s not going to be enough dollars to go around to meet the demand.

Buck: So let me ask you something. Part of what you were talking about with gold. I’ve always sort of been of the thought that gold is almost sort of like the anti-dollar right gold goes up you know they’re sort of inversely related, but did I get you right in that part of your theory is that gold and the dollar kind of go up simultaneously and if so how is that possible?

Brent: Yeah so it’s a great question and so again I think it depends on if you’re just looking at those two currencies then they both can’t go up together. One of them is going to rise versus the other one. But the point that I like to make as part of my theory is I think we’re going to get into a place where the dollar and gold are rising together versus everything else. So if you just look at gold in the dollar they both can’t rise together. But if you consider all the different assets in the world and all the different currencies and all the different choices, I think the two most important assets that you can own over the next two to three to five years is dollars and gold because I think versus all the other currencies and many other asset classes those two assets are going to perform better than anything else and so and so and so you know again it kind of depends on how you in other words while doll while gold might go up versus the dollar I think it will go up even more versus the Euro or even more versus the yen or the Australian dollar or whatever it is.

Buck: So let’s talk about like based on this theory and I know you’ve got your work is basically around this and your funds and stuff but at a high level, what are some of the like concepts to model your portfolio or to consider in your personal portfolio? I mean how do you design something like that? What are some of the big concepts?

Brent: Sure so I think this is where it kind of gets important to layout different time frames and I always say that I’m gonna first of all I’m gonna tell you exactly how I think asset prices are gonna play out over the next two to three years, that doesn’t necessarily mean that’s what I think is going to happen over the next two or three months. So in general the Milkshake Theory says that the US Dollar is going to rise versus all of the currencies over the next two or three years. The rise of the dollar is going to create chaos in the monetary system. It will create a number of crises around the world where you know asset prices in Canada and Australia and Europe and Africa and South America will go down because the dollar will squeeze those countries and I think the flight into the dollar will mean that the liquidity comes to United States it goes into US asset prices so we will be able to continue to finance our treasury by the flow of capital. I think US stock prices will go higher over the next couple years I’m not sure about real estate I think real estate I don’t think real estate is going to crash but I don’t necessarily think real estate is going to go through the roof, but I think I think what happens is we get this melt-up for lack of a better word in US Dollar and US asset prices and we get this meltdown in the rest of the world. Now I don’t think that that’s going to happen over the next two or three months it could but I actually think that we’re in for another pullback in US equities let’s call it between some time over the next nine months and when that happens you know I think that would or would if we do get a second wave of Covid or whatever it is you know there’s a number of you know when these dollar payments have to be made again we think there’s a number of people that are going to go bankrupt etc but then when we get further into the crisis when this starts happening on a global basis and the global capital really starts flowing to the United States out of a flight to safety so to speak that’s when we think that we will get this melt-up where the stock market will go back to its all-time highs and even higher. I just don’t think we’re there right now today.

Buck: So we’re talking about you know two or three years you know just sort of ride this out at that point and then what would happen after that?

Brent: After that, what I think will happen and you know the bottom line is that the dollar just you cannot have a strong dollar for a long period of time because it literally it just wrecks the monetary system and there’s a whole concept that goes back to I think it was the 60s there was an economist named Robert Triffin and he basically said if you have an individual country’s currency which also acts as the global reserve currency that all other countries use, then at some point, and it might take a long time, but at some point, the needs of the domestic economy will come into conflict with the needs of the global economy. And this kind of goes right into the heart of Trump’s Make America Great Again. You know for the dollar, for the monetary system to function as it does we have had to offshore all of our manufacturing to other countries and so we supply the dollars they supply the goods and that’s how the whole country the whole global monetary system works. But Trump has tried to reverse that he wants to bring the manufacturing back, he wants us to export less and import, or he wants us to export more and import less. Well, this is the exact thing, Triffin’s dilemma. This is the domestic economy coming into conflict with the international commodity economy or the global economy. So I think that’s what’s going to take. We’re already there we’re kind of in that now but I think it’s going to get exacerbated over the next couple years and essentially I think it will cause so many problems the strong dollar will cause so many problems that they will have to do something to redesign the monetary system or weaken the dollar because the system just won’t function with a really strong dollar and so what I think will probably have like another plaza accord type deal you know back in the 80s the dollar got really strong and a bunch of the countries got together and they artificially weakened the dollar because it was causing problems. I think something like that will happen again and I think that’s when that’s I think so the dollar will get weakened either artificially or because of a redesign of the monetary system or whatever and I think that will be the time to then get out of the US Dollar and get out of US assets and then go buy the international markets or the markets that have been beaten up as the dollar got stronger so basically you flip it and do exactly the opposite, but I think that’s a couple of years away.

Buck: How do you time that though?

Brent: I mean it’s hard because it’s very hard.

Buck: Because by the time they announce like some sort of you know meeting that looks like the plaza accord I think everybody’s already there right?

Brent: Well I think listen I’m I’m not arrogant enough to think that I’m going to be able to time this perfectly, but I think we’re a I don’t think we’re close to that yet and I think there has to be a lot more pain before we get to something like that and so while I’m in in our separately managed accounts that we oversee for clients, we’re largely trying to protect against this chaos that we see coming, but then I mentioned to you that we have a private fund that we manage and in that private fund we’re actually trying to profit from this chaos that we see coming and the thing is that most people think that if you go around and you survey financial institutions and asset managers and currency experts the majority but the far majority of people believe that over the next two or three years the dollar is going to weaken because of the amount of stimulus that the fed is providing and policies etc etc. If you look at traders positioning you know people are very short the dollar they’re very long the Euro. So the most people don’t think the dollar is going to go higher over the next couple years partly because it just can’t be allowed to happen because it creates so many problems but what that sets up is it sets up an opportunity to where if it does happen, you can make a lot of money because not many people think it will happen so the odds are kind of in your favor and the pricing of these trades to do if the dollar does get strong is very much in your favor. So we’ve set this fund up to where if we’re even a little bit right we have the opportunity to make a lot of money and so what we’ve said is that you shouldn’t put your whole portfolio into this fund, but this is a way to put you know as an example five percent of your portfolio into this fund and if we’re right that five percent has the opportunity to do very well and help hedge against the rest of your portfolio in the chaos, or even a source of to make a lot of money and if we’re wrong and we lose half of it or whatever it is well then that must mean the rest of the world’s doing fine, the other 95 percent of the portfolio is doing very well and more than making up for this hedge. But the trades the dollar trades that we’re looking at are very asymmetric so it’s an opportunity to bet a little in order to make a lot. It’s kind of like an insurance policy that you know nobody thinks they’re going to wreck their car the next day nobody thinks that their house is going to burn down that night but they have but they buy the insurance policy just in case it does right so maybe you pay you know ten thousand dollars a year in insurance on your house but if your house burns down they give you a million bucks to rebuild it or what or whatever it is and so that that’s kind of how we view this as well.

Buck: Got it. So one other question and maybe our last you know question on this is what things could happen that would potentially you know what would sort of break your theory? Like you know what are the unexpected things that happen that you know make it so that the theory kind of is no longer possible?

Brent: Right well there’s a couple things that could happen. Number one the theory could be delayed in other words I think it’ll play out over the next two or three years what is possible and again this isn’t my base case but I can’t rule it out is that you know the fed and the monetary authorities are able to do something over the next six months, 12 months to push the dollar much lower another 10 percent lower or something, in which case they push the problem off into the future and then it takes another year two years three years for my thesis to play out again. So maybe it’s possible that I’m early. The only way I can figure out if I’m completely wrong is if if the if Trump and the treasury were to come out overnight and artificially just write down the dollar overnight and come out and say we have you know Trump says I’ve instructed Mnuchin to do whatever he needs to do to get the dollar index from 95 to 65 over the next six months you know whether they go out and they buy they print dollars and they buy foreign currencies or they pay gold higher or whatever it is, in that scenario, our thesis would not play out on a currency basis, however, the interesting thing is that in itself would cause a bunch of chaos. You know the the dollar getting written down 20 or 30 percent or whatever it is you have to remember that makes the Euro go up 20 or 30 percent it makes the yen go up 20 or 30 percent makes the yuan go up 20 or 30 percent those economies it would be very hard for those economies to sustain a 20 or 30 rise in their currencies. So then they would have to come out and try to write down their currencies and so in that chaos we think we would still make some money but it would potentially derail the overall thesis that I have as far as a whole milkshake right.

Buck: Right so like an all-out currency war.

Brent: Yeah

Buck: Well listen this has been really useful and educational for us all, Brent. It’s Santiago Capital in San Francisco. Investors need to be they need to have a net worth of over two million dollars to participate, that doesn’t mean that’s your investment but that’s your net worth. How do people get in touch with you if they’re interested in potentially participating in your fund.

Brent: Sure well if you just go to brent@santiagocapital.com or you send me an email brent@santiagocapital.com. I also have a website it’s just a basic website it just has my contact information but it’s santiagocapital.com. I’m pretty active on twitter @SantiagoAUfund is my handle but if you just type in Santiago Capital you’ll probably find me I’m pretty active on there again and I’m happy to share my contact info with you and if any of your listeners contact you, feel free to forward them on to me you know and I always say this and I’ll tell you it’s getting harder and harder to do because I get a lot of emails and phone calls and direct messages but I do try to answer everybody and if you send me a message and I don’t answer you feel free to send another one I will eventually get to it I won’t ignore you forever and I’m always happy to try to help people.

Buck: That’s great, fantastic, Brent, and again thanks for coming on the show, and hopefully we can you know have you on again sometime as this thing plays out in the next few years.

Brent: Yeah I’d be happy to do that and I appreciate you guys taking the time to hear my thoughts.

Buck: We’ll be right back.